What are shares?
A share is a security that represents the ownership of a fraction of a company. As a result, the owner of the share is entitled to a share of the assets and profits of the corporation equal to the proportion of shares he owns. A share is therefore a form of security that indicates that the owner has a proportional interest in the issuing company. Corporations sell shares to raise funds for the operation of their businesses.
Shares are mainly bought and sold on stock exchanges, although there may also be private sales. Thus, securities are the actual basis for the portfolios of many individual investors. Transactions involving shares must comply with government regulations designed to protect investors from fraudulent practices. Historically, they have outperformed most other investment opportunities over the long term.
How do shares work?
The owner of shares (a shareholder) has now purchased a piece of the corporation and, depending on the type of shares held, may be entitled to a portion of its assets and income. In other words, a shareholder is now an owner of the issuing corporation. Ownership is determined by the number of shares a person owns in relation to the number of shares outstanding. For example, if a company has 1,000 shares outstanding and a person owns 100 shares, that person would own and be entitled to 10% of the assets and income of the company.
Shareholders do not own stock corporations; they own shares issued by stock corporations. But joint-stock companies are a special type of organization because the law treats them as legal entities. In other words, corporations levy taxes, can take out loans, own property, can be sued, etc. The idea that a corporation is a “person” means that the corporation owns its own assets. A corporate office full of chairs and tables belongs to the corporation and not to the shareholders.
This distinction is important because the property of the corporation is legally separate from the property of the shareholders, which limits the liability of both the corporation and the shareholder. If the company now goes bankrupt, a judge can order the company to give up all its assets but your personal assets are not at risk. The court cannot even force you to sell your shares, although the value of your shares will have fallen dramatically. Similarly, if a major shareholder goes bankrupt, he cannot sell the assets of the company to pay off his creditors.
Shareholders and shareholdings
What the shareholders actually own are the shares issued by the company; and the corporation owns the assets held by a company. So if you own 33% of the shares of a company, it is wrong to say that you own one-third of that company; instead, it is right to say that you own 100% of one-third of the shares of the company. Shareholders cannot do what they want with a corporation or their assets. A shareholder cannot go out with a chair because the corporation owns that chair and not the shareholder. This is known as the “separation of ownership and control”.
Owning shares gives you the right to vote at shareholders’ meetings, to receive dividends (representing the profits of the corporation) if and when they are distributed, and it gives you the right to sell your shares to someone else.
If you have a majority of shares, your voting rights increase, so you can indirectly control the management of a company by appointing the board of directors. This becomes most obvious when one company buys another: The acquiring company does not buy the building, chairs and employees, but all the shares. The board of directors is responsible for increasing the value of the company and often does so by hiring professional managers or executives, such as the chief executive officer or the CEO.
For most common shareholders, not being able to run the company is not such a big deal. The importance of shareholder ownership is that you are entitled to a share of the company’s profits, which, as we will see, is the basis for the value of a share. The more shares you own, the greater the share of profits you receive. However, many shares do not pay dividends, but reinvest the profits back into the growth of the company. These retained earnings are still reflected in the value of a share, however.
Common shares vs. preferred shares
There are two main types of shares: common shares and preferred shares. Ordinary shares generally entitle the owner to vote at shareholders’ meetings and to receive dividends paid by the company. Preference shareholders generally have no voting rights, although they have a greater claim to assets and profits than ordinary shareholders. For example, holders of preference shares receive dividends before ordinary shareholders and have priority in the event of bankruptcy and liquidation of a company.
Companies can issue new shares whenever there is a need for additional cash. This procedure dilutes the ownership and rights of existing shareholders (provided they do not buy any of the new shares). Companies may also participate in share buybacks, which would benefit existing shareholders by increasing the value of their shares.